Tuesday, November 29, 2011

As the House Financial Services Committee prepares to markup and approve three pieces of derivatives legislation, the banking industry announced its strong support for measures relating to inter-affiliate swaps and swap execution facilities. In a letter to Chairman Spencer Bachus (R-ALA) and other members of the Committee, the American Bankers Association endorsed H.R. 2779, which would clarify that inter-affiliate swaps should be exempt from many of the anticipated SEC and CFTC swap regulations.

Inter-affiliate swaps do not create additional counterparty exposure outside of the corporate group, noted the ABA, and do not increase interconnectedness between third parties. In fact, said the banking association, inter-affiliate trades reduce systemic risk by making it possible to increase the use of netting with clients and by bringing together a diversified portfolio in one entity to use more offsets to manage and reduce risk. For some financial institutions, inter-affiliate swaps are an important tool to accommodate customer preferences and manage interest rate, currency exchange, or other balance sheet risks that arise from the normal course of business. Failing to pass HR 2779 would undermine bank internal risk management procedures, posited the ABA.

The ABA also supports HR 2586, the Swap Execution Facility Clarification Act, which would clarify that a swap execution facility cannot be required to have a minimum number of participants, receive or respond to quote requests, or display quotes for a certain period of time. Further, the SEC and CFTC would not be permitted to limit the means of contract execution or require trading systems to interact with each other. Absent HR 2586 and the clarifications it provides, said the ABA, the regulations will limit the availability of swaps and constrain liquidity in a manner inconsistent with Congressional intent.

The Business Risk Mitigation and Price Stabilization Act, HR 2682, would clarify that end users would not be subject to margin requirements for uncleared swaps. The Dodd-Frank Act does not require regulators to impose margin requirements on end users, noted the ABA, and the legislative history makes it clear that Congress did not intend to impose margin requirements on end users. Nonetheless, end users currently face uncertainty about whether they will be subject to margin requirements, said the banking association, and this legislation would provide much-needed clarity.

The ABA supports an end-user exemption from margin requirements for uncleared swaps and believes that all end users, including banks that use swaps to hedge or mitigate risk, should be exempt. However, HR 2682 would limit the margin exemption to end users that are not financial entities. Imposing margin requirements on any end users would discourage the use of swaps to hedge or mitigate risk, reasoned the ABA, so it would both increase risk in the system and vitiate the end-user clearing exemption.

If the Committee wants to make a distinction between the margin requirements for bank end users and other end users, emphasized the ABA, then the Committee should consider imposing only variation margin for end-user banks, rather than both initial and variation margin requirements.